Is Debt Destiny?
Argentina, Emerging Markets, and the Future of Finance

On December 23, 2001 Argentina declared its inability to continue to service its outstanding debt, triggering the largest default in international financial history. Two weeks later (January 6, 2002) the government suspended the convertibility of pesos into dollars bringing an end to Argentina's decade long experiment with a currency board. What happened? How had Argentina gotten so deeply into debt? Where was the International Monetary Fund? How had the fabled international financial markets failed to notice the perilous fragility of Argentine finances? What did it all mean for the future of Argentina and the prospects for future capital flows to the emerging market countries?

To answer these questions, the Program on Science, Technology, America, and the Global Economy (STAGE) and the Latin American Program (LAP) co-hosted a discussion with Paul Blustein, International Economic Correspondent for The Washington Post. The meeting highlighted Blustein's recently published book And The Money Kept Rolling In (And Out): Wall Street, the IMF, and the Bankrupting of Argentina. Joseph S. Tulchin, Director of the Wilson Center's Latin American Program and Claudio Loser, former head of the IMF's Western Hemisphere Department provided commentary.

In Blustein's view, the blame for Argentina's financial collapse was widely shared. Argentines themselves were at the head of the parade. The decision to link the peso to the dollar eliminated Argentina's ability to use monetary policy or adjust its exchange rate. With fiscal policy the only tool available, Argentina should have pursued a very strict fiscal policy during the boom years of 1993-98. It did not. The proceeds from extensive privatization of government assets went largely to consumption, rather than to reduction of the budget deficit. Nor did Argentina attempt to reduce the independence of the provinces, which could and did issue their own international debt.

Shifts in the global economy created added problems for the Argentines. In the late 1990s, the price of Argentina's grain, beef and other exports declined on world markets. At the same time, the U.S. dollar (and thus the Argentine peso) gained in value (or appreciated) relative to other currencies making Argentine exports more expensive on world markets.

Despite the structural problems and the growing risk of default, the International Monetary Fund continued to provide new loans for Argentina. When the IMF did offer cautionary advice, it was often drowned out by a flood of money flowing to Argentina from Wall Street and other financial centers around the world.

Blustein was particularly scathing in his comments on Wall Street. An early hint of his view is contained in the dedication of this book: "To my children: Nina, Nathan, Dan, and Jack, whom I will always love unconditionally even if they go to work on Wall Street" (emphasis added). Blustein detailed the same kind of conflicts of interest that came to light in the wake of Enron's 2001 collapse in the United States. Analysts were pressured by investment bankers to shade their reports at the cost of individual or pension fund investors.

Have the markets learned their lesson? Blustein is skeptical. He pointed to emerging market debt that was only requiring a premium over US Treasury bonds (viewed as the world's safest investment) of only three to four percentage points. With interest rates low around the world, investors were scouring the world for investments that paid higher interest rates. They have found them in the emerging market countries.

With his IMF background, Claudio Loser was more positive on the IMF's role. He cited the example of the early 1980s where the IMF was warning Mexico before it neared default. Its advice was ignored as bankers lined up to lend to Mexico. Bonuses for bankers were tied to making loans – risk seemed to have slipped out of the equation.

In the case of Argentina, Loser stressed that the IMF staff was not happy with Argentina's decision to move from floating exchange rates to the fixed rate required by peso convertibility to the dollar. He also noted that the IMF did warn Argentina about being on the road to financial difficulties – but to no avail.

Joseph S. Tulchin insisted on the need to bring politics, particularly Argentine politics, back into the equation. He noted that Argentine President Menem abused the system of subsidies to the provinces in order to maintain power. In evaluating emerging markets, the investor must be aware that institutions are often weak. In the case of Argentina, there is no evidence that they took advantage of the good years in the 1990s or that they are making good use of the commodity boom in the early 21st century.

What should be done? Blustein has a number of suggestions, only three of which are highlighted here. First, emerging market countries and developing countries generally should adopt a Chilean like system of taxing short-term capital flows to discourage speculation. He cites a recent study by four IMF economists indicating that "there is as yet no clear and robust empirical proof" that countries grow faster by linking their financial systems more deeply to the outside world.

Second, Blustein urges the IMF to provide, in general, only a conventional level of loans. Where exceptional national circumstances require a larger loan or where the international financial system itself may be at risk, the IMF should have a clear justification that is made transparent to the financial world.

Third, Blustein noted the difficulty of countries in default negotiating with a host of creditors. In many cases, a handful of creditors can resist settlement. Argentina is facing just this challenge. While the bulk of its creditors have accepted a settlement, perhaps as many as twenty-five percent have not yet settled. Blustein favors resuscitating the Sovereign Debt Restructuring Mechanism, which creates a kind of bankruptcy procedure for countries and forces all creditors to the same negotiating table.

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